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Two long wars, chronic deficits, the financial crisis, the costly drug war, the growth of executive power under Presidents Bush and Obama, and the revelations about NSA abuses, have given rise to a growing libertarian movement in our country – with a greater focus on individual liberty and less government power. David Boaz’s newly released The Libertarian Mind is a comprehensive guide to the history, philosophy, and growth of the libertarian movement, with incisive analyses of today’s most pressing issues and policies.

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Is QE3 about Bernanke’s Employment?

The Federal Reserve’s latest round of quantitative easing — an open-ended monetary stimulus policy that has been dubbed “QE3” — has elicited the expected responses: applause from Democrats who want stronger Fed action, and alarm from Republicans who view it as highly inflationary. The Fed’s sudden interest in reducing unemployment, as opposed to earlier Fed actions that were intended to prop up the financial sector, is not directly supported by the data: neither the unemployment rate nor the share of the population employed have worsened significantly and output growth remains positive.

High unemployment associated with the recent recession has persisted despite gigantically loose monetary policy, implying that other constraints were also at work. But recent positive economic indicators suggest that a recovery is already in train. If these salutary developments persist, the Fed’s latest move should be viewed as opportunistic rather than essential for sparking a recovery. Indeed, it could turn out to be destabilizing.

Economists Kenneth Rogoff and Carmen Reinhardt have convincingly compiled historical evidence to argue that because it takes a long time to restore lending institutions’ balance sheets, recoveries following recessions triggered by a financial crisis can take four years or longer. The Fed’s unprecedented earlier rounds of quantitative easing, QE1 and QE2, were designed to accommodate impaired assets with financial institutions, purchasing and holding them until a recovery could begin. Recent economic data suggest this balance sheet repair is now ramping up: lending institutions’ assets are growing again, including their portfolios of loans and leases. Their overall share of noncurrent loans and leases is declining.

And household and corporate and noncorporate business sector portfolios now hold smaller shares of liquid checking, saving, and money-market assets, and larger shares of other, riskier financial assets. Greater willingness to hold riskier assets means more effective financial intermediation for broader, higher-return investments. Recent statistics on housing starts and new home sales also portend an upsurge next year.

Given these indicators of an incipient recovery, the timing of the Fed’s latest policy of open-ended purchases of new mortgage-backed securities is curious, even disconcerting. Despite positive economic developments, the Fed has chosen to undertake nontrivial and open-ended monetary injections, packing inflationary potential into an economy already flush with cash. That potential is heightened today because the Fed is adding reserves at the same time that the private nonfinancial sector is reducing its liquid holdings.

One rationale for adopting such a policy now is that it will improve the Fed’s credibility. Fed officials have early and deep access to national economic data. As professional economists, they are able to closely view, analyze, and project the future course of the economy. True, such ability is not absolute and error-free. However, given its knowledge of key lead and lag relationships between financial and economic variables, Fed forecasts about the future course of the economy can be quite good, if not highly accurate.

What would a Fed chairman do if his position and policies were being attacked from all sides? To preserve the Fed’s independence and increase its public credibility, the Fed and its chairman need to be seen as national saviors that pushed the economy out of an Endless Recession, and just in time for Bernanke’s term expiration and possible reappointment early in 2014. Between nine and 12 months from today, when national output and employment gather steam, the stock market is higher by 20 percent or more, employment is recovering, and the unemployment rate is showing unmistakable decline, we’ll salute the Fed. And the association of these developments with QE3 won’t be viewed as the false (or premeditated) positive that it may really be.

Congress’s failure to appropriately curb “fiscal cliff” tax increases and spending cuts scheduled under current federal budget policies could upset this calculation. But that possibility only reinforces the Fed’s latest initiative. And if Congress appropriately navigates upcoming “fiscal cliff” issues, the economy may be boosted and the Fed could recalibrate monetary injection schedules.

The problem is the possibilities don’t end there. The ingrained danger in the Fed’s latest move is that it will eventually wade into waters that are too deep. If the economy surges rapidly next year, the Fed may be unable to quickly unwind its large asset portfolio, eroding its ability to curb inflation and control rising inflation expectations. We know well that putting the inflation genie back into the bottle is an extremely difficult and painful process. The Fed’s recent move, then, targets preservation of its own independence and credibility in the short term, but compromises the ability to control inflation in the long term.